Transparency may be a concept most often discussed in the context of financial reporting, but a recent decision by accounting rulemakers will force companies to think more about transparency as they compile their tax returns.
Bortman
It’s a foreign notion to tax specialists. “I don't think I’ve ever heard a tax person, except for a government tax person, say he or she favored transparency,” says Eli Bortman, a business and law professor at Babson College. “That's a financial accounting concept.”
Yet companies may be forced to shift their thinking as they comply with an interpretation issued last week by the Financial Accounting Standards Board. The standard—Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes—spells out how FASB wants companies to display information about tax benefits they expect to receive and are reporting on their balance sheets, yet that might not pass muster with tax authorities.
FIN 48 maps out a formula for how companies should assess, for financial reporting purposes, positions they’ve taken on their tax returns that they are not sure will stand up to an audit or other legal challenge. It requires companies to put a total dollar figure on the amount of tax benefit that they expect, but can’t be sure they’ll reap from such positions, and make some footnote disclosures about the nature of their uncertainties.
Companies initially protested FASB’s interpretation because the Board wanted companies to show tax benefits on the balance sheet only if they deemed those positions as “probable” of enduring Internal Revenue Service scrutiny. Though not precisely defined in accounting literature, the “probable” threshold is generally believed to be around 70 to 80 percent.
Tax law, however, allows companies to take a position on the tax return that has as little as 30 to 40 percent likelihood of standing up to a challenge without incurring a penalty. FASB’s interpretation prods companies to illuminate that chasm of uncertainty with more balance sheet disclosures.
Following the comment and deliberation process, FASB ultimately decided to adopt a lower threshold of certainty in FIN 48, determining that companies could show a tax benefit on the balance sheet if it was “more likely than not” to pass the tax review unscathed. That means if companies are at least 51 percent certain they’ll win the tax benefit, they can show it as a tax benefit on the balance sheet. Albeit smaller, the gap of uncertainty with certain tax positions still must be reported as such on the balance sheet and described in footnotes.
Companies worried that such disclosures would force them to tip their hand to tax authorities, providing auditors with a roadmap to more aggressively audit tax returns. FASB was sensitive to the concern, and devised a formula where companies report aggregate figures, not necessarily specific transactions, to minimize undue exposure to audit scrutiny.
An Audit Roadmap?
Bortman says companies have legitimate reason to take a position with tax authorities that wouldn’t stand up to the same level of certainty for financial reporting purposes. For example, a company may expect to be eligible for a research and development credit, but can’t be sure at the time it prepares its financial statements.
“When I fill out a balance sheet, I’m making some assumptions about what will be on my tax return,” he says. “FASB is saying you ought to highlight that in some fashion … It’s not a situation where a company is trying to hide something. We’re not talking about fraud.”
Dean Jorgensen, managing partner for the national tax office of Grant Thornton, says FASB’s original statement on accounting for income taxes, Financial Accounting Standard No. 109, doesn’t clearly say how companies should account for uncertainties. Companies subsequently developed various approaches, leading to a lack of comparability.
With FIN 48, companies now have a formula for how to assess whether a tax benefit belongs on the balance sheet and how to disclose tax positions that are deemed uncertain for financial reporting purposes.
From Jorgensen’s perspective, companies have a legitimate concern that the new disclosures may give tax authorities an audit roadmap in certain instances. Although required disclosures do not compel companies to give details about specific tax issues or jurisdictions in which the issues arise, the nature of the disclosures could identify certain tax issues.
If, for example, a company must disclose that its certainty about a specific tax amount is tied to an expiring statute of limitations, that could signal auditors to examine specific tax returns more closely, Jorgensen says.
Still, Jorgensen contends that tax experts must recognize that FASB’s role is transparency of financial reporting, not firmness of footing in tax returns. The Securities and Exchange Commission is “already on record for transparency,” he says. “Rulemakers have already examined the issue and set it aside.”
Aksak
John Aksak, a tax accountant and managing director with True Partners Consulting, says FASB isn’t necessarily trying to do the IRS’s bidding, but simply looking for greater consistency in financial reporting. “Within the last year there have been more disclosures about what’s going on with taxes,” he says. “This is trying to get more uniformity in tax disclosures.”
Aksak says the aggregation of uncertain positions makes it less likely tax auditors could use financial statements to search for prospective tax-reporting problems. “Auditors know there’s a certain amount of uncertainty in every corporate tax return,” he says. “Their audit decisions tend to be driven more by their own past knowledge of the taxpayer they’re looking at. Some companies because of their complexity tend to have more issues that aren’t clear.”
Separately, FASB also issued a staff position last week that says companies must recalculate their leveraged leases if the timing of the related tax benefits will affect corporate cash flows.
FASB said leveraged leases can provide significant tax benefits to the party leasing property or equipment, and it wants to see the economic reality of the related tax benefit for those transactions reflected in the accounting. FASB issued the staff position in tandem with its interpretation of uncertain tax positions, as they both related to FAS No. 109 on accounting for income taxes.
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